FORM 10-Q

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

(Mark One)

|X|  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

For the quarterly period ended September 30, 1998

                                       OR

| |  TRANSITION   REPORT   PURSUANT  TO SECTION  13  OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

For the transition period from ________ to ___________

                         Commission file number: 0-15997

                               FILENET CORPORATION
             (Exact name of Registrant as specified in its charter)

        Delaware                                  95-3757924
------------------------------    ----------------------------------------------
 (State or other jurisdiction          (I.R.S. Employer Identification No.)
 of incorporation or organization)


             3565 Harbor Boulevard, Costa Mesa, CA 92626
----------------------------------------------------------------------
         (Address of principal executive offices) (Zip code)

                           (714) 966-3400
----------------------------------------------------------------------
         (Registrant's telephone number including area code)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes |X| No |_|

As of October 31, 1998, there were 31,815,512 shares of the Registrant's  common
stock outstanding.



<PAGE>


                               FILENET CORPORATION
                                      Index


                                                                        Page
                                                                       Number
--------------------------------------------------------------------------------

PART I.  FINANCIAL INFORMATION

Item 1.  Consolidated Balance Sheets
         as of September 30, 1998 and December 31, 1997.................  3

         Consolidated Statements of Operations
         for the three and nine month periods ended September 30,
         1998 and 1997..................................................  4

         Consolidated Statements of Comprehensive Income
         for the three and nine month periods ended
         September 30, 1998 and 1997....................................  5

         Consolidated Statements of Cash Flows
         for the nine month periods ended September 30, 1998 and 1997...  6

         Notes to Consolidated Financial Statements.....................  7

Item 2.  Management's Discussion and Analysis of Financial Condition
         and Results of Operations...................................... 10

PART II  OTHER INFORMATION

Item 1.  Legal Proceedings.............................................. 19

Item 6.  Exhibits and Reports on Form 8-K............................... 19

         SIGNATURE...................................................... 20

         INDEX TO EXHIBITS.............................................. 21

                                       2
<PAGE>
PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

                               FILENET CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                      (In thousands, except share amounts)
<TABLE>
<CAPTION>
                                               September 30,            December 31,
                                                   1998                    1997
                                             ----------------        ----------------
                                                (Unaudited)
<S>                                          <C>                     <C>
 ASSETS
 Current assets:
   Cash and short-term marketable securities   $       69,839         $       63,944
   Accounts receivable, net                            62,149                 61,283
   Inventories                                          3,030                  3,541
   Prepaid expenses and other current assets            9,096                  8,309
   Deferred income taxes                                5,885                  6,439
                                              ----------------        ---------------
   Total current assets                               149,999                143,516

 Property, net                                         37,452                 27,587
 Long-term marketable securities                       12,454                  7,826
 Other assets                                           1,049                    941
                                              ----------------        ---------------
   Total assets                                $      200,954         $      179,870
                                              ================        ===============

 LIABILITIES AND STOCKHOLDERS' EQUITY
 Current liabilities:
   Accounts payable                            $       16,606         $       15,003
   Accrued compensation                                15,959                 14,845
   Unearned maintenance revenue                        13,473                  8,848
   Accrued royalties                                    1,766                  2,743
   Other accrued liabilities                           22,478                 19,190
                                              ---------------         ---------------
    Total current liabilities                          70,282                 60,629

 Deferred income taxes                                    460                    430

 Stockholders' equity:
   Preferred stock - $.10 par value;
     7,000,000 shares authorized; none
     issued and outstanding
   Common stock - $.01 par value; 100,000,000 shares authorized;  31,686,928 and
     31,121,676 shares  outstanding at September 30, 1998 and December 31, 1997,
     respectively 143,567 130,741
   Retained earnings                                    3,727                  2,348
   Accumulated other comprehensive income              (2,515)                (4,146)
                                              ----------------        ---------------
                                                      144,779                128,943
   Treasury stock, at cost; 1,098,000 and
     820,000 shares at September 30, 1998
     and December 31, 1997, respectively              (14,567)               (10,132)
                                              ----------------        ---------------
   Total stockholders' equity                         130,212                118,811
                                              ----------------        ---------------
    Total liabilities and
    stockholders' equity                       $      200,954         $      179,870
                                              ================        ===============
See accompanying notes to consolidated financial statements.
</TABLE>
                                       3
<PAGE>

                                    FILENET CORPORATION
                           CONSOLIDATED STATEMENTS OF OPERATIONS
                           (In thousands, except per share data)


<TABLE>
<CAPTION>


                                      Three Months Ended Sept. 30,         Nine Months Ended Sept. 30,
                                  -----------------------------------------------------------------------
                                        1998              1997               1998               1997
                                  ----------------  ----------------  ---------------   -----------------
                                   (Unaudited)        (Unaudited)       (Unaudited)        (Unaudited)
<S>                               <C>                <C>              <C>               <C>
 Revenue:
   Software                       $        36,128    $       34,684   $       123,777  $         87,841
   Service                                 29,763            23,713            82,702            65,206
   Hardware                                 5,261             6,614            18,654            21,976
                                  ----------------   ---------------  ----------------  -----------------
    Total revenue                          71,152            65,011           225,133           175,023

 Costs and expenses:
   Cost of software revenue                 4,850             4,058            12,801            10,223
   Cost of service revenue                 18,712            14,010            52,025            40,906
   Cost of hardware revenue                 3,043             5,063             9,641            15,230
   Research and development                12,915             9,613            36,808            29,346
   Selling, general and
     administrative                        40,877            30,624           115,030            91,411
   Restructuring and other
     costs                                                                                        6,000
                                  ---------------   ---------------    --------------   -----------------
   Total costs and expenses                80,397            63,368           226,305           193,116
                                  ---------------   ---------------    --------------   -----------------

 Operating income (loss)                   (9,245)            1,643            (1,172)         (18,093)


 Other income, net                          1,102               984             3,113             2,285
                                  ---------------   ---------------    --------------   -----------------

 Income (loss) before                      (8,143)            2,627             1,941          (15,808)
  income taxes

 Provision (benefit) for
  income taxes                             (2,364)              736               560           (4,425)

                                  ---------------   ---------------    --------------   ----------------

 Net income (loss)                $        (5,779)  $         1,891    $        1,381   $      (11,383)
                                  ================  ===============    ==============   ================

 Earnings (loss) per share:
   Basic                          $         (0.18)  $          0.06    $         0.04   $         (0.38)
   Diluted                        $         (0.18)  $          0.06    $         0.04   $         (0.38)


 Weighted average shares
  outstanding:
   Basic                                    31,526           30,512            30,843            30,331
   Diluted                                  31,526           31,230            33,733            30,331
</TABLE>


See accompanying notes to consolidated financial statements.
                                       4
<PAGE>


                                    FILENET CORPORATION
                      CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                                      (In thousands)
<TABLE>
<CAPTION>
                                              Three Months Ended Sept. 30,           Nine Months Ended Sept. 30,
                                         -------------------------------------   -----------------------------------
                                                 1998               1997               1998               1997
                                         -----------------   ----------------    ----------------   ----------------
                                             (Unaudited)        (Unaudited)        (Unaudited)        (Unaudited)
<S>                                      <C>                 <C>                 <C>                <C>
 Net income (loss)                               (5,779)              1,891              1,381           (11,383)
                                         ----------------    ----------------    ----------------   ----------------

 Other comprehensive income:
   Foreign currency translation
      adjustments, net of tax                    (2,238)             (1,371)             1,580            (5,190)
   Unrealized gains (losses) on securities:
     Unrealized holding gains (losses) arising
      during period, net of tax                    (37)                (66)                43               (75)
     Reclassification adjustment for gains
      (losses)included in net income,
       net of tax                                                                           7
                                         ----------------    ----------------    ----------------   ----------------
 Total other comprehensive income (loss)        (2,275)             (1,437)             1,630             (5,265)
                                         ----------------    ----------------    ----------------   ----------------

 Comprehensive income (loss)                   (8,054)                454              3,011            (16,648)
                                         ================    ================    ================   ================
</TABLE>

























See accompanying notes to consolidated financial statements.

                                       5
<PAGE>

                                    FILENET CORPORATION
                           CONSOLIDATED STATEMENTS OF CASH FLOWS
                                      (In thousands)
<TABLE>
<CAPTION>

                                                                                Nine Months Ended Sept. 30,
                                                                             ----------------------------------
                                                                                   1998              1997
                                                                             --------------    ----------------
                                                                              (Unaudited)        (Unaudited)
 <S>                                                                         <C>               <C>
 Cash flows from operating activities:
 Net income (loss)                                                                   1,380            (11,383)
 Adjustments to reconcile net loss to net cash
   provided by operating activities:
     Depreciation and amortization                                                  11,090              9,947
     Provision for doubtful accounts                                                   694                264
     Deferred income taxes                                                             598                586
     Changes in operating assets and
   liabilities, net of acquisition:
       Accounts receivable                                                            (388)            23,826
       Inventories                                                                     511              3,395
       Prepaid expenses and other current assets                                      (714)               882
         Accounts payable                                                            1,463             (3,888)

       Accrued compensation
                                                                                       983              2,257
       Unearned maintenance revenue
                                                                                     4,652              1,819
       Accrued royalties                                                              (977)            (2,029)
       Other                                                                         2,676             (7,316)
                                                                             --------------    ----------------
 Net cash provided by operating activities                                          21,968             18,360
                                                                             --------------    ----------------
 Cash flows from investing activities:
 Proceeds from sale of equipment                                                       446                407
 Capital expenditures                                                              (21,117)            (9,184)
 Purchases of marketable securities                                                (25,601)           (22,462)
 Proceeds from sales and maturities of marketable
   securities                                                                       37,044             26,921
                                                                             --------------    ----------------
 Net cash used by investing activities                                              (9,228)            (4,318)
                                                                             --------------    ----------------

 Cash flows from financing activities:
 Proceeds from issuance of common stock                                             12,827              2,338
 Common stock repurchased                                                           (4,435)                 -
                                                                             --------------    ----------------
 Net cash provided by financing activities                                           8,392              2,338
                                                                             --------------    ----------------
 Effect of exchange rate changes on cash and cash equivalents                          613             (2,108)
                                                                             --------------    ----------------
 Net increase in cash and cash equivalents                                          21,745             14,272
 Cash and cash equivalents, beginning of year                                       37,344             28,530
                                                                             --------------    ----------------
 Cash and cash equivalents, end of period                                           59,089             42,802
                                                                             ==============    ================

 Supplemental cash flow information:
 Interest paid                                                                          67                187
 Income taxes paid (refund)                                                           (281)             2,768
</TABLE>


See accompanying notes to consolidated financial statements.
                                        6
<PAGE>

                               FILENET CORPORATION
                   Notes To Consolidated Financial Statements
                                   (Unaudited)

1.   In the opinion of the management of FileNET  Corporation  ("the  Company"),
     the  accompanying   unaudited  consolidated  financial  statements  reflect
     adjustments  (consisting  of normal  recurring  adjustments)  necessary  to
     present fairly the financial  position of the Company at September 30, 1998
     and the results of its operations,  its  comprehensive  income and its cash
     flows for the three and nine month  periods  ended  September  30, 1998 and
     1997.  Certain  information and footnote  disclosures  normally included in
     financial  statements have been condensed or omitted  pursuant to rules and
     regulations of the Securities and Exchange Commission ("SEC"), although the
     Company  believes  that  the  disclosures  in  the  consolidated  financial
     statements  are  adequate  to  ensure  the  information  presented  is  not
     misleading.  These  consolidated  financial  statements  should  be read in
     conjunction with the consolidated  financial  statements and notes thereto,
     and Management's Discussion and Analysis of Financial Condition and Results
     of Operations contained in the Company's Annual Report on Form 10-K for the
     fiscal year ended December 31, 1997 and the Company's  Quarterly Reports on
     Form 10-Q for the quarters ended March 31 and June 30, 1998. The results of
     operations for the interim  periods are not  necessarily  indicative of the
     operating results for the year.

2.   In May 1998, the Company effected a two-for-one  split of its common stock.
     All references in the consolidated financial statements to number of shares
     and per share amounts of the  Company's  common stock have been restated to
     reflect the split.

3.   Certain  reclassifications  have been made to the prior year's consolidated
     financial statements to conform with the current year's presentation.

4.   The following table is a  reconciliation  of the earnings and share amounts
     used in the  calculation of basic  earnings per share and diluted  earnings
     per share for the three and six-month periods ended September 30, 1998.

<TABLE>
<CAPTION>

     <S>                                            <C>            <C>          <C>
                                                                                   Per
                                                       Net                        Share
     (In thousands, except per share amounts)         Income         Shares       Amount
                                                    ------------   ----------   -----------

      Three months ended September 30, 1998
          Basic earnings per share                  $   (5,779)    $  31,526    $   (0.18)
          Effect of dilutive stock options                             2,612
                                                    ------------   ----------
          Diluted earnings per share                $   (5,779)    $  34,138    $   (0.17)
                                                    ============   ==========

      Three months ended September 30, 1997
          Basic earnings per share                  $    1,891     $  30,512    $    0.06
          Effect of dilutive stock options                                 -
                                                    ------------   ----------
          Diluted earnings per share                $    1,891     $  30,512    $    0.06
                                                    ============   ==========

      Nine months ended September 30, 1998
          Basic earnings per share                  $    1,380     $  30,843    $    0.04
          Effect of dilutive stock options                             2,890
                                                    ------------   ----------
          Diluted earnings per share                $    1,380     $  33,733    $    0.04
                                                    ============   ==========

      Nine months ended September 30, 1997
          Basic earnings per share                  $ (11,383)     $  30,331    $   (0.38)
          Effect of dilutive stock options                                 -
                                                    ------------   ----------
               Diluted earnings per share           $ (11,383)     $  30,331    $   (0.38)
                                                    ============   ==========
</TABLE>
                                       7
<PAGE>



5.   In June 1997,  the  Financial  Accounting  Standards  Board  (FASB)  issued
     Statement  of  Financial  Accounting  Standard  (SFAS) No. 130,  "Reporting
     Comprehensive   Income."  SFAS  No.  130  requires  enterprises  to  report
     comprehensive  income  and  its  components  in  general-purpose  financial
     statements.  SFAS No. 130 is effective for the Company beginning January 1,
     1998.  Accordingly,  the Company has prepared  Statements of  Comprehensive
     Income for the three and nine month  periods  ended  September 30, 1998 and
     1997  (restatement  of prior year financial  statements is required by SFAS
     No. 130).  Accumulated other comprehensive  income as of September 30, 1998
     is comprised of the following:

<TABLE>
<CAPTION>
     <S>                             <C>                <C>                  <C>
                                                                                Accumulated
                                                          Unrealized Gain         Other
                                          Foreign          on Marketable      Comprehensive
     (In thousands)                    Currency Items       Securities            Income
                                     -----------------  -----------------    ------------------
      Balance, December 31, 1997       $     (4,121)      $          (25)      $      (4,146)

      Current period changes                  1,586                   44               1,630
                                     -----------------  -----------------    ------------------
      Balance, Sept. 30, 1998          $     (2,535)      $           19       $      (2,516)
                                     =================  =================    ==================

</TABLE>

6.   In June 1997, the FASB issued SFAS No. 131,  "Disclosures about Segments of
     an  Enterprise  and Related  Information"  which is effective  for the year
     ending December 31, 1998. The Company has not yet determined the impact, if
     any, of adopting this standard on its financial statements.

In   June  1998,  the FASB  issued  SFAS No.  133,  "Accounting  for  Derivative
     Instruments  and Hedging  Activities,"  which is effective for fiscal years
     beginning  after June 15, 1999. SFAS 133 will require the Company to record
     all derivatives on the balance sheet at fair value.  For  derivatives  that
     are hedges,  changes in the fair value of derivatives will be offset by the
     change  in  fair  value  of  the  hedged  assets,   liabilities,   or  firm
     commitments.  The Company  has not yet  determined  the impact,  if any, of
     adopting this standard on its financial statements.

7.   In October 1994,  Wang  Laboratories,  Inc. (Wang) filed a complaint in the
     United States  District  Court for the District of  Massachusetts  alleging
     that the  Company is  infringing  five  patents  held by Wang (the  FileNET
     Case).  On June  23,  1995,  Wang  amended  its  complaint  to  include  an
     additional  related patent.  On July 2, 1996, Wang filed a complaint in the
     same court alleging that Watermark, formerly a wholly-owned subsidiary that
     was  merged  into the  Company,  is  infringing  three of the same  patents
     asserted in the initial complaint (the Watermark Case). On October 9, 1996,
     Wang  withdrew  its claim in the  FileNET  Case that one of the  patents it
     initially  asserted  is  infringed  by the  Company's  products  that  were
     commercialized  before the initial  complaint was filed.  Wang reserved the
     right to assert that patent against the Company's  products  commercialized
     after that date in a separate lawsuit.

     In March 1997,  Eastman  Kodak Company  (Kodak)  purchased the Wang imaging
     business unit that has responsibility  for this litigation.  The patents in
     the suit have been  transferred  to a Kodak  subsidiary,  Kodak  Limited of
     England,  which,  in turn, has  exclusively  licensed them to another Kodak
     subsidiary,  Eastman Software, Inc. in the United States (Eastman). On July
     30, 1997,  the court  permitted  Eastman and Kodak Limited of England to be
     substituted in the litigation in place of Wang.

     FileNET has moved for summary judgment on noninfringement as to each of the
     five patents in the suit, and for summary  judgment of invalidity as to one
     of  the  patents.  Eastman  moved  for  summary  judgment  as to  FileNET's
     unenforceability  defense on one of the patents.  A trial date has not been
     set.

     If it should be determined  that the patents at issue in the litigation are
     valid and are infringed by any of the Company's  products the Company will,
     depending on the product, redesign the infringing product or seek to obtain
     a license to market the product. There can be no assurance that the Company
     will be able to obtain  such a license on  acceptable  terms.  Based on the
     Company's  analysis of these patents and their  respective  file histories,
     the Company  believes that it has meritorious  defenses to claims at issue;
     however,  the ultimate  outcome or any resulting  potential  loss cannot be
     determined at this time.

     On December 20,  1996,  plaintiff  Michael I. Goldman  filed a class action
     complaint  against the Company and certain of its officers and directors in
     the  Superior  Court of  California,  County of Orange (the  Goldman  State
     Action).  The  action  was  purportedly  filed  on  behalf  of a  class  of
     purchasers of the Company's common stock during the period October 19, 1995
     through  July 2, 1996.  The  plaintiff  alleges  that the Company and other
     defendants  violated Cal. Corp. Code ss.ss. 25400 and 25500, Cal. Civ. Code
     ss.ss.  1709-1710  and Cal.  Bus.  & Prof.  Code  ss.ss.  17200 et seq.  in
     connection  with various public  statements made by the Company and certain
     of its  officers  and  directors  during  the  putative  class  period.  On
     September  30,  1998,  the Court  entered an order  dismissing  this action
     without prejudice.

     On April 1, 1997,  plaintiff  Michael I. Goldman filed another class action
     complaint  against the Company and certain of its officers and directors in
     the United  States  District  Court for the Central  District of California
     (the Goldman Federal Action). The action purportedly was filed on behalf of
     the same class of purchasers  of the Company's  common stock as the Goldman
     State Action.  The allegations  contained in the Goldman Federal Action are
     very  similar to the  allegations  contained in the Goldman  State  Action,
     except that the Goldman  Federal Action asserts claims under Sections 10(b)
     and 20(a) of the  Securities  Exchange Act and Rule 10b-5On  September  23,
     1998,  the Court  entered an order  dismissing  this action in its entirety
     without prejudice.


     On October 23, 1998,  plaintiff  Avram Gart filed a class action  complaint
     against  the  Company  and certain of its  officers  and  directors  in the
     Superior Court of California, County of Orange (the Gart State Action). The
     action  was  purportedly  filed on behalf of a class of  purchasers  of the
     Company's  common stock during the period January 13, 1998 through  October
     7, 1998.  The plaintiff  alleges that the Company and the other  defendants
     violated Cal. Corp. Code ss.ss.  25400 and 25500 in connection with various
     public  statements  made by the  Company and  certain of its  officers  and
     directors during the putative class period. The complaint seeks unspecified
     compensatory damages, rescission, interest, attorneys' fees, expert witness
     fees and costs,  and  equitable or injunctive  relief.  The Company has not
     been served with the complaint.

     On October 27,  1998,  plaintiff  Thomas P.  Nyquist  filed a class  action
     complaint  against the Company and certain of its officers and directors in
     the United  States  District  Court for the Central  District of California
     (the Nyquist Federal Action). The action was purportedly filed on behalf of
     a class of purchasers of the Company's common stock during the period April
     16, 1998  through  October 7, 1998.  The  plaintiff  alleges  claims  under
     Sections 10(b) and 20(a) of the  Securities  Exchange Act and Rule 10b-5 in
     connection  with various public  statements made by the Company and certain
     of its  officers  and  directors  during the  putative  class  period.  The
     complaint seeks  unspecified  compensatory  damages,  interest,  attorneys'
     fees,  expert witness fees and costs.

     The Company  believes  that all of the  allegations  contained  in the Gart
     State Action and the Nyquist  Federal  Action are without merit and intends
     to defend the actions vigorously.

     The Company, in the normal course of business,  is subject to various other
     legal  matters.  While the  results  of  litigation  and  claims  cannot be
     predicted with  certainty,  the Company  believes that the final outcome of
     these  other  matters  will  not  have a  material  adverse  effect  on the
     Company's consolidated results of operations or financial condition.





<PAGE>


Item 2.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

The following  should be read in  conjunction  with the  unaudited  consolidated
financial  statements  and notes thereto  included in Part I--Item 1 and Factors
That May Affect Future Results in this item of this Quarterly  Report,  and with
the  audited   consolidated   financial   statements  and  notes  thereto,   and
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations  contained in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997.

Results of Operations

Revenue
<TABLE>
<CAPTION>
                                      Three Months Ended Sept. 30,          Nine Months Ended Sept. 30,
                                    ----------------------------------   ----------------------------------
                                    ----------------------------------   ----------------------------------
                                        1998         1997       Change       1998         1997       Change
                                    ----------   ----------  ---------   ----------  -----------  ---------
<S>                                 <C>          <C>            <C>      <C>         <C>               <C>
(Dollars in millions)
 Software revenue
   Domestic                          $   22.2     $   21.9         1%     $   78.4    $    58.3         35%
   International                         13.9         12.9         8%         45.3         29.6         53%
                                    ----------   ----------              ----------  -----------
   Total software revenue            $   36.1     $   34.8         4%     $  123.7    $    87.9         41%
                                    ----------   ----------              ----------  -----------
     Percentage of total revenue          51%          54%                     55%          50%

 Service revenue
   Domestic                          $   23.1     $   17.9        29%     $   64.1    $    49.8         29%
   International                          6.7          5.8        16%         18.7         15.4         21%
                                    ----------   ----------              ----------  -----------
   Total service revenue             $   29.8     $   23.7        26%     $   82.8    $    65.2         27%
                                    ----------   ----------              ----------  -----------
     Percentage of total revenue          42%          36%                     37%          37%

 Hardware revenue
   Domestic                          $    4.1     $    4.6      (11%)     $   13.6    $    15.7        (13%)
   International                          1.2          1.9      (37%)          5.0          6.2        (19%)
                                    ----------   ----------              ----------  -----------
   Total hardware revenue            $    5.3     $    6.5      (18%)     $   18.6    $    21.9        (15%)
                                    ----------   ----------              ----------  -----------
     Percentage of total revenue           7%          10%                      8%          13%

 Total revenue
   Domestic                          $   49.4     $   44.4        11%     $  156.1    $   123.8         26%
   International                         21.8         20.6         6%         69.0         51.2         35%
                                    ----------   ----------              ----------  -----------
   Total revenue                     $   71.2     $   65.0        10%     $  225.1    $   175.0         29%
                                    ==========   ==========              ==========  ===========
</TABLE>

Software revenue from the licensing of the Company's software products increased
4% and 41% for the three and nine month periods,  respectively,  ended September
30, 1998 over the  comparable  periods of 1997.  The  increases  were  primarily
attributable  to an increase in the volume of product  shipments,  including the
Company's  Panagon  product line which was released  during the first quarter of
1998.  Revenue in the third  quarter of 1998 was impacted  negatively by reduced
add-on sales of the Company's  Image  Management  System (IMS) line of products.
The  magnitude  of the  increase in year to date  revenue over 1997 is partially
attributable  to weakness in orders  during the first quarter of 1997 and is not
indicative of future revenue growth.

Service  revenue  consists  of  revenue  from  software  maintenance   services,
professional services, training, repairs and supplies. Service revenue increased
26% and 27% for the three and nine month periods, respectively,  ended September
30, 1998 over the comparable periods of 1997. The increases were attributable to
increased  maintenance revenue due to the growth of the Company's installed base
and to increased demand for the Company's professional service offerings.

                                       10
Hardware revenue is generated primarily from the sale of 12-inch optical storage
and retrieval  libraries  (OSARs) and  third-party  hardware.  Hardware  revenue
decreased  by 18% and 15% for the three and nine  month  periods,  respectively,
ended  September 30, 1998 from the  comparable  periods of 1997 primarily due to
decreases in new orders  experienced both domestically and  internationally  and
the Company's  focus on  increasing  its higher margin  software  revenues.  The
Company expects hardware revenue to continue to decline in both absolute dollars
and as a percentage of total revenues as it continues to transition its business
toward software and service-related revenue.

International  revenues constituted  approximately 31% and 32% of total revenues
in the three month periods ended September 30, 1998 and 1997, respectively.  For
the nine month periods ended September 30, 1998 and 1997, international revenues
constituted  approximately  31% and 29% of  total  revenues,  respectively.  The
increases in the proportion of international  revenues for the nine months ended
September  30, 1998 is  attributable  to the higher level of growth  experienced
internationally.  A  portion  of this  growth is  attributable  to  weakness  in
international  orders during the first quarter of 1997 and is not  indicative of
future  international  revenue  growth.  Management  expects that the  Company's
international  operations will continue to account for a significant  portion of
total  revenues.  However,  the ongoing global  economic  crisis could adversely
affect  international  revenues.  In addition,  international  revenues could be
adversely  affected  if  the  U.S.  dollar  strengthens  against   international
currencies.

Cost of Revenue
<TABLE>
<CAPTION>

                                      Three Months Ended Sept. 30,          Nine Months Ended Sept. 30,
                                    ----------------------------------   ----------------------------------
                                       1998         1997       Change       1998        1997        Change
                                    ----------   ----------  ---------   ----------  -----------  ---------
<S>                                  <C>          <C>           <C>       <C>         <C>             <C>
(Dollars in millions)
 Cost of software revenue            $    4.8     $    4.0       20%      $   12.8    $   10.2         25%
  Percentage of software revenue         13%          11%                     10%         12%
 Cost of service revenue             $   18.7     $   14.0       34%      $   52.0    $   40.9         27%
  Percentage of service revenue          63%          59%                     63%         63%
 Cost of hardware revenue            $    3.1     $    5.1      (39%)     $    9.7    $   15.2        (36%)
  Percentage of hardware revenue         58%          78%                     52%         69%
 Total cost of revenue               $   26.6     $   23.1                $   74.5    $   66.3         12%
  Percentage of total revenue            37%          36%                     33%         38%
</TABLE>

The cost of software  revenue  includes  royalties paid to third parties and the
cost of software  distribution.  The cost of software revenue as a percentage of
software  revenue for the three months ended September 30, 1998 increased to 13%
from 11% for the  comparable  period in 1997.  The increase was primarily due to
increased  third  party  royalty  costs.  The  cost  of  software  revenue  as a
percentage  of software  revenue for the nine months  ended  September  30, 1998
decreased  to 10% from 12% for the  comparable  period in 1997.  The decrease is
primarily  attributable  to the low revenue  levels in the first quarter of 1997
without a corresponding  decrease in fixed distribution costs. Also contributing
to the  decrease  was the fact  that  software  localization  costs  which  were
classified  as cost of  revenue in 1997 have been  classified  as  research  and
development in 1998.

The cost of service revenue includes software support and professional  services
personnel,  supplies, and the cost of third-party hardware maintenance. The cost
of service revenue as a percentage of service revenue for the three month period
ended  September 30, 1998 increased to 63% from 59% in the comparable  period of
1997.  The increase is  attributable  to the higher  proportion  of lower margin
professional services in the service revenue mix.

The  cost  of  hardware  revenue  includes  the  cost  of  manufacturing  OSARs,
third-party  purchased hardware and the cost of hardware integration  personnel.
The cost of hardware  revenue as a percentage of hardware  revenue for the three
month  period  ended  September  30,  1998  decreased  to 58%  from  78% for the
comparable  period of 1997. For the nine month period ended  September 30, 1998,
cost of hardware revenue  decreased to 52% from 69% for the comparable period of
1997.  These decreases were due to improved product mix and a reduction in fixed
manufacturing costs.


<PAGE>

Operating Expenses
<TABLE>
<CAPTION>

                                      Three Months Ended Sept. 30,          Nine Months Ended Sept. 30,
                                    ----------------------------------   ----------------------------------
                                       1998         1997       Change       1998         1997       Change
                                    ----------   ----------  ---------   ----------  -----------  ---------
<S>                                  <C>          <C>             <C>     <C>         <C>              <C>
(Dollars in millions)
 Research and development            $   12.9     $     9.6       34%     $   36.8    $    29.3        26%
  Percentage of total revenue             18%          15%                     16%          17%
 Selling, general and
  administrative                     $   40.9     $   30.6        34%     $  115.0    $    91.4        26%
  Percentage of total revenue             57%          47%                     51%          52%
</TABLE>


Research and development  expenses  increased 34% and 26% for the three and nine
month periods ended September 30, 1998, respectively, compared to the comparable
periods of 1997.  The increases  were due to a general  increase in salaries and
recruiting  costs  necessitated  by  the  intense  competitive  environment  for
software engineers;  increase in cost of contract developers;  and the inclusion
of  software  localization  costs in  research  and  development  in 1998.  As a
percentage of total revenue,  research and development expenses increased to 18%
for the three month period ended  September 30, 1998 from 15% for the comparable
period of 1997. The increase was  attributable  to lower revenue growth rates in
the third  quarter of 1998.  As a  percentage  of total  revenue,  research  and
development  expenses decreased to 16% for the nine month period ended September
30, 1998 from 17% for the comparable  period of 1997. This decrease is primarily
attributable  to the effects of the lower revenue levels in the first quarter of
1997.

The Company  expects that  competition  for qualified  technical  personnel will
remain  intense for the  foreseeable  future and may result in higher  levels of
compensation  expense for the Company.  The Company  believes  that research and
development  expenditures,  including  compensation of technical personnel,  are
essential to  maintaining  its  competitive  position and expects these costs to
continue to constitute a significant percentage of revenues.

Selling, general and administrative expenses increased 34% and 26% for the three
and nine month periods ended September 30, 1998,  respectively,  compared to the
comparable periods of 1997. This increase was primarily due to overall increases
in salaries,  higher sales incentive  compensation  due to increased  revenues a
change in the sales channel mix, and increased  marketing  program  costs.  As a
percentage  of total  revenue,  selling,  general  and  administrative  expenses
increased to 57% for the three months ended  September 30, 1998 from 47% for the
comparable  period of 1997  primarily  due to sales  productivity  growing  at a
lesser rate than sales related expenses.

Provision for Income Taxes The  Company's  combined  federal,  state and foreign
annual  effective tax rate for the nine months ended  September 30, 1998 was 29%
(expense) compared to 28% (benefit) for the comparable period in 1997.

Foreign  Currency  Fluctuations  and Inflation The Company's  performance can be
affected by changes in foreign  currency  values  relative to the U.S. dollar in
relation to the  Company's  revenue and  operating  expenses.  The impact to net
income from foreign exchange  transactions and hedging  activities is immaterial
for all periods  reported.  As of September  30,  1998,  the Company had forward
exchange  contracts   outstanding  totaling   approximately  $5  million  in  11
currencies. All of these contracts mature in three months.

Other comprehensive income for the  three and nine month periods ended September
30, 1998 reflects decreases of $2,238,000 and $1,580,000,  respectively, in  the
unrealized  loss  due  to  foreign   currency translation. These  decreases were
primarily attributable to unrealized gains associated with the  strengthening of
the Irish currency against the U.S. dollar during the respective periods.

Management  believes  that  inflation  has not had a  significant  impact on the
prices of the Company's  products,  the cost of its materials,  or its operating
results for the three and nine month periods ended September 30, 1998 and 1997.

Other Financial  Instruments  The Company enters into forward  foreign  exchange
contracts as a hedge against effects of fluctuating  currency  exchange rates on
monetary  assets  and  liabilities  denominated  in  currencies  other  than the
functional  currency of the  relevant  entity.  The Company is exposed to market
risk on the  forward  exchange  contracts  as a result  of  changes  in  foreign
exchange  rates;  however,  the market  risk  should be offset by changes in the
valuation  of the  underlying  exposures.  Gains and losses on these  contracts,
which equal the difference  between the forward contract rate and the prevailing
market spot rate at the time of valuation,  are  recognized in the  consolidated
statement of  operations.  The  counterparties  to these  instruments  are major
financial institutions.  The Company uses commercial rating agencies to evaluate
the credit quality of the counterparties,  and the Company does not anticipate a
loss resulting from any credit risk of these institutions.

Liquidity and Capital Resources

At September 30, 1998,  combined cash, cash equivalents and short- and long-term
marketable  securities totaled $82.3 million,  an increase of $10.5 million from
the end of 1997.  Cash provided by operating  activities  during the nine months
ended  September 30, 1998 totaled $18.7 million and resulted  primarily  from an
increase  in unearned  maintenance  revenue  related to growth in the  Company's
installed base; and additions to net income for  depreciation  and  amortization
expense. Cash used by investing activities totaled $9.2 million and was a result
of capital expenditures offset by sales and maturities of marketable securities.
Cash provided by financing  activities  totaled $8.4 million and was a result of
proceeds  received  from the exercise of employee  stock  options and  purchases
under the  employee  stock  purchase  plan offset by the  repurchase  of 139,000
shares of the Company's common stock.

Accounts receivable  increased to $62.1 million at September 30, 1998 from $61.3
million at December 31, 1997. Days sales outstanding  increased to 79 days as of
September  30,  1998 from 72 days as of  December  31,  1997.  The  increase  is
attributable to slower  payments being  experienced  internationally  and in the
Company's reseller channel.  Current  liabilities  increased to $70.3 million at
September  30, 1998 from $60.6  million at December  31,  1997.  The increase in
current  liabilities  is primarily a result of  increases  in accounts  payable,
accrued incentive  compensation,  unearned  maintenance  revenue and cooperative
marketing cost accruals.

The Company has a $20 million  unsecured line of credit with a commercial  bank.
This line of credit  expires in May 1999 and is subject  to the  maintenance  of
certain financial covenants. The Company also has several borrowing arrangements
with  foreign  banks which  expire at various  times during 1998 under which the
Company may borrow  approximately  $2 million.  As of September 30, 1998,  there
were no borrowings outstanding against any of the Company's credit lines.

During the first quarter of 1998,  the Company  repurchased  $4.4 million of its
common stock,  thereby  completing  its  previously  announced $10 million stock
repurchase program.

The Company  anticipates that its present cash balances together with internally
generated  funds and credit lines will be sufficient to meet its working capital
and capital expenditure needs for at least the next twelve months.

Other Matters

Year 2000 With the  approach  of the year  2000,  the  Company  recognized  that
significant issues could arise in connection with the computer software products
it  licenses  and the  internal  business  systems  which are  essential  to its
operations.  As a result, the Company  implemented a year 2000 Integrity Program
("the Program") in 1997 to ensure that the Company's  computer software products
and  internal  business  systems  will  function  properly  in the year 2000 and
thereafter.  The Program as it relates to the software  products licensed by the
Company  includes  year 2000  compliance  testing and  certification  of certain
existing  software  products.  All new  generations  of the  Company's  software
products  will be released  as year 2000  compliant.  Not all  current  software
products of the Company are year 2000 compliant and the Company does not plan to
make them so. Upgraded,  year 2000 compliant  versions of such software products
are being made  available  to  customers  and  resellers  who will then bear the
responsibility  for  installing the upgraded  software  product in order to make
their systems year 2000 compliant.  Some of the Company's  customers are running
software product versions that are not year 2000 compliant. The Company has been
encouraging such customers to migrate to current software product  versions.  It
is possible  that the Company may  experience  increased  expenses in addressing
migration issues for such customers. The Company's customer support organization
initiated a program, Customer Service Profile 2000, to review the status of each
Company's product currently installed at a customer location and it provided the
same  diagnostics  to its resellers for their use at their  customer  locations.
Customers  who have  support  agreements  with the  Company  have been  directly
informed  as to  whether  or not the  particular  software  products  they  have
installed  are year 2000  compliant.  All  customers  are kept  informed  of the
release of year 2000 compliant  updates and upgrades via the Company's web site.
Risks from the inability of any of the Company's  software  products to properly
manage and manipulate  data in the year 2000 could result in increased  warranty
costs,  customer  satisfaction  issues,  potential  lawsuits and other costs and
liabilities, as well as customers being unable to run software licensed from the
Company  and   incurring   significant   costs  from  the   resultant   business
interruption.  Demand for the  Company's  software  products  could be adversely
impacted  to the  extent  customers  and  potential  customers  are  temporarily
distracted  by  their  year  2000  remediation   efforts,  as  it  competes  for
information  technology  resources  that have been  diverted  for such  remedial
efforts which may have higher  priority than  implementing  document  management
systems.

The Company has also initiated  communications  with its significant third party
vendors of computer  software with which the Company's systems interface or upon
whom the Company's software products depend, in order to coordinate efforts with
these outside third parties to minimize the extent to which its business will be
vulnerable  to such  third  parties'  failure to  remediate  their own year 2000
issues.   Although  the  Company's  compliance  testing  utilizes  the  embedded
third-party  software as an essential  part of its software  being  tested,  the
Program does not include certification of customer-developed  applications which
run  on the  Company's  software  products  or  third-party  software  which  is
incorporated  in the Company's  software  products.  Customers  and  third-party
vendors will remain directly  responsible  for year 2000  compliance  testing of
their software.

The  Program  also  includes  a review  of all  internal  systems  for year 2000
compliance. The Company's significant business systems (financial,  operational,
customer  support) are under review and are either currently year 2000 compliant
or will be  upgraded  and/or  replaced so as to be year 2000  compliant  by July
1999.  All of the  hardware  and software  deployed in the  Company's  technical
infrastructure  is  either  fully  year 2000  compliant  or is  scheduled  to be
replaced with year 2000 compliant  components by the end of 1998. The Company is
also evaluating its environmental systems (heating, air conditioning,  security)
and intends to make all such systems year 2000  compliant by the end of 1998. To
the extent  possible,  the Company will be developing and executing  contingency
plans  designed  to allow  continued  operation  in the event of  failure of the
Company's or third parties'  systems.  For those  business,  infrastructure  and
environmental  systems  that are to be  upgraded  in order to achieve  year 2000
compliance,  the majority were already  scheduled for upgrade for other business
reasons and any additional  implementation  costs directly  associated  with the
year 2000 problem are not material.

Although  the Company is not aware of any material  operational  issues or costs
associated  with  preparing its software  products and internal  systems for the
year  2000,  there can be no  assurance  that  there  will not be a delay in, or
increased costs associated with, the implementation of the necessary systems and
changes  to  address  the year  2000  issues,  and the  Company's  inability  to
implement  such  systems  and  changes  could have an  adverse  effect on future
results of operations. The costs of the Company's year 2000 project and the date
on which the Company  believes it will be  completed  are based on  management's
best estimates and include assumptions regarding third party modification plans.
However,  in particular due to the potential impact of third party  modification
plans,  there can be no  assurance  that these  estimates  will be achieved  and
actual results could differ materially from those anticipated.

The  foregoing  statements  are based upon  management's  best  estimates at the
present  time,  which were  derived  utilizing  numerous  assumptions  of future
events,  including the continued availability of certain resources,  third party
modification  plans and other  factors.  There can be no  guarantee  that  these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include,  but are not limited to, the nature and amount of programming  required
to upgrade or replace  each of the  affected  programs,  and the  success of the
Company's external customers,  resellers and vendors and suppliers in addressing
the year 2000 issue.

The EURO Conversion On January 1, 1999,  eleven of the fifteen member  countries
of the European Union are scheduled to establish fixed  conversion rates between
their existing sovereign currencies and the EURO. These countries have agreed to
adopt the EURO as their common legal  currency on that date.  The EURO will then
trade on currency  exchanges and be available for non-cash  transactions.  These
countries will issue sovereign debt  exclusively in EURO and will  re-denominate
outstanding  sovereign  debt.  Effective on this date,  these  countries will no
longer  control their own monetary  policies by directing  independent  interest
rate for the  legacy  currencies.  Instead,  the  authority  to direct  monetary
policy, including money supply and official interest rates for the EURO, will be
exercised by the new European Central Bank.

Following  introduction  of the EURO,  the legacy  currencies  are  scheduled to
remain legal tender in these  countries  as a  denomination  of the EURO between
January  1, 1999 and  January  1, 2002 (the  "transition  period").  During  the
transition  period,  public and private  parties may pay for goods and  services
using either the EURO or the country's  legacy currency on a "no compulsion,  no
prohibition"  basis.  However,  conversion  rates  no  longer  will be  computed
directly from one legacy currency to another. Instead, a "triangulation" process
will be applied whereby an amount  denominated in one legacy currency first will
be  converted   into  an  amount   denominated   in  EURO,   and  the  resultant
EURO-denominated amount is converted into the second legacy currency.

The Company is in the process of  evaluating  the impact the  conversion  to the
EURO will have on its financial  condition and results of  operations.  Based on
this evaluation to date, the Company  currently does not believe there will be a
material impact on its financial  condition or results of operations as a result
of the EURO  conversion,  except that the Company  cannot  currently  assess the
impact  that a common  EURO-based  price  list will have on how it  markets  its
products in Europe nor the impact, if any, on revenues generated in Europe.

Environmental  Matters  The  Company  is not  aware  of any  issues  related  to
environmental  matters  that have,  or are expected  to,  materially  affect its
business.

Factors That May Affect Future Results

The Company's business, financial condition, operating results and prospects can
be impacted by a number of factors, including but not limited to those set forth
below and  elsewhere in this report,  any one of which could cause the Company's
actual  results to differ  materially  from recent results or from the Company's
anticipated future results.

Rapid  Technological  Change;  Product  Development The market for the Company's
products is characterized by rapid technological developments, evolving industry
standards,   changes  in  customer   requirements   and   frequent  new  product
introductions  and  enhancements.   The  Company's  continued  success  will  be
dependent upon its ability to continue to enhance its existing products, develop
and introduce,  in a timely  manner,  new products  incorporating  technological
advances  and respond to customer  requirements,  including  without  limitation
enhancements to certain specified Company software products to achieve year 2000
compliance.  The Company could  experience  difficulties or delays in developing
and introducing new products or integrating  some or all of the technologies and
products from acquisitions, with the technologies and products from the Company.
Delays in or non-completion of the development of newly integrated products,  or
lack of market acceptance of such products,  could have an adverse impact on the
Company's  future  results of operations  and result in a failure to realize the
anticipated  benefits  of the  acquisitions.  To the  extent  one or more of the
Company's  competitors  introduce  products  that more  fully  address  customer
requirements,  the Company's business could be adversely affected.  There can be
no assurance  that the Company will be successful  in  developing  and marketing
enhancements to its existing  products or new products on a timely basis or that
any new or enhanced  products will adequately  address the changing needs of the
marketplace.  If the Company is unable to develop and  introduce new products or
enhancements  to existing  products  in a timely  manner in response to changing
market  conditions  or  customer   requirements   including  without  limitation
enhancements  to  certain  existing  software  products  to  achieve  year  2000
compliance,  the  Company's  business and  operating  results could be adversely
affected.  From time to time,  the Company or its  competitors  may announce new
products,  capabilities  or  technologies  that have the potential to replace or
shorten  the life cycles of the  Company's  existing  products.  There can be no
assurance that announcements of currently planned or other new products will not
cause  customers to delay their  purchasing  decisions in  anticipation  of such
products,  which could have a material adverse effect on the Company's  business
and operating results.

Uncertainty Of Future  Operating  Results;  Fluctuations In Quarterly  Operating
Results Prior growth rates in the Company's revenue and operating results should
not necessarily be considered  indicative of future growth or operating results.
Future operating results will depend upon many factors, including the demand for
the Company's  products,  the effectiveness of the Company's efforts to continue
to integrate  various products it has developed or acquired through  acquisition
of  others  and to  achieve  the  desired  levels  of sales  from  such  product
integration,  the level of  product  and price  competition,  the  length of the
Company's sales cycle,  improvements in the  productivity of the Company's sales
force,  seasonality of individual customer buying patterns,  the size and timing
of individual transactions,  the delay or deferral of customer  implementations,
the  budget  cycles  of the  Company's  customers,  the  timing  of new  product
introductions and product  enhancements by the Company and its competitors,  the
mix of  sales  by  products,  services  and  distribution  channels,  levels  of
international  sales,  acquisitions by competitors,  changes in foreign currency
exchange rates  including EURO exchange rates  beginning in 1999, the ability of
the Company to develop and market new  products and control  costs,  and general
domestic and  international  economic and political  conditions.  As a result of
these  factors,  revenues and  operating  results for any quarter are subject to
variation and are not predictable with any significant degree of accuracy.

Therefore, the Company believes that period-to-period comparisons of its results
of operations  are not  necessarily  meaningful and should not be relied upon as
indications  of future  performance.  Moreover,  such  factors  could  cause the
Company's  operating  results in a given quarter to be below the expectations of
public market analysts and investors. In either case, the price of the Company's
common stock could be materially adversely affected.

Competition The document  imaging,  workflow,  computer output to laser disk and
document  management  software  markets  are highly  competitive,  and there are
certain competitors of the Company with substantially greater sales,  marketing,
development and financial  resources.  The Company believes that the competitive
factors  affecting the market for its products and services  include  vendor and
product reputation;  product quality, performance and price; the availability of
products on multiple platforms;  product  scalability;  product integration with
other  enterprise  applications;  product  functionality  and features;  product
ease-of-use;  and the quality of customer  support  services and  training.  The
relative  importance of each of these factors depends upon the specific customer
involved.  While the Company  believes it  competes  favorably  in each of these
areas,  there can be no assurance that it will continue to do so. Moreover,  the
Company's  present  or  future  competitors  may be  able  to  develop  products
comparable  or  superior to those  offered by the  Company,  offer lower  priced
products or adapt more quickly than the Company to new  technologies or evolving
customer  requirements.  Competition  is expected to  intensify.  In order to be
successful  in the future,  the Company  must respond to  technological  change,
customer  requirements and competitors' current products and innovations.  There
can be no assurance  that it will be able to continue to compete  effectively in
its market or that future competition will not have a material adverse effect on
its business, operating results and financial condition.

Intellectual Property and Other Proprietary Rights The Company's success depends
in part on its ability to protect  its  proprietary  rights to the  technologies
used  in  its  principal  products.  The  Company  relies  on a  combination  of
copyrights,   trademarks,   trade   secrets,   confidentiality   procedures  and
contractual  provisions  to  protect  its  proprietary  rights.  There can be no
assurance that the Company's  existing or future copyrights,  trademarks,  trade
secrets or other  intellectual  property  rights will be of sufficient  scope or
strength  to  provide  meaningful  protection  or  commercial  advantage  to the
Company.  FileNET  has no  software  patents.  Also,  in selling  certain of its
products,  the Company  relies on "shrink wrap"  licenses that are not signed by
licensees  and,  therefore,  may be  unenforceable  under  the  laws of  certain
jurisdictions.  In addition,  the laws of some foreign  countries do not protect
the Company's proprietary rights to the same extent as do the laws of the United
States.  There can be no assurance  that such factors  would not have a material
adverse effect on the Company's business or operating results.

The  Company  may from time to time be notified  that it is  infringing  certain
patent or  intellectual  property  rights of others.  Combinations of technology
acquired through past or future  acquisitions and the Company's  technology will
create new products and technology that may give rise to claims of infringement.
While no  actions  other than the ones  discussed  below are  currently  pending
against the Company for  infringement of patent or other  proprietary  rights of
third  parties,  there can be no assurance  that third parties will not initiate
infringement actions against the Company in the future. Infringement actions can
result in substantial cost to and diversion of resources of the Company.  If the
Company were found to infringe  upon the rights of others,  no assurance  can be
given that licenses  would be  obtainable  on  acceptable  terms or at all, that
significant  damages for past infringement would not be assessed or that further
litigation  relative to any such licenses or usage would not occur.  The failure
to successfully  defend any claims or obtain necessary licenses or other rights,
the ultimate  disposition of any claims or the advent of litigation  arising out
of any  claims of  infringement,  could have a  material  adverse  effect on the
Company's business, financial condition or results of operations.

In October 1994,  Wang filed a complaint in the United States District Court for
the  District of  Massachusetts  alleging  that the Company is  infringing  five
patents held by Wang. On June 23, 1995, Wang amended its complaint to include an
additional  related patent.  On July 2, 1996, Wang filed a complaint in the same
court  alleging that  Watermark,  formerly a  wholly-owned  subsidiary  that was
merged into the Company, is infringing three of the same patents asserted in the
initial  complaint.  On October 9, 1996, Wang withdrew its claim that one of the
patents it initially  asserted is infringed by the Company's products which were
commercialized  before the initial  complaint was filed. Wang reserved the right
to assert that patent against the Company's products  commercialized  after that
date in a  separate  lawsuit.  Based on the  Company's  analysis  of these  Wang
patents and their  respective file histories,  the Company  believes that it has
meritorious  defenses to Wang's  claims;  however,  the ultimate  outcome or any
resulting potential loss cannot be determined at this time.

In March 1997,  Eastman  Kodak  Company  ("Kodak")  purchased  the Wang  imaging
business unit that has  responsibility  for this litigation.  The patents in the
suit have been  transferred  to a Kodak  subsidiary,  Kodak  Limited of England,
which in turn has exclusively licensed them to another Kodak subsidiary, Eastman
Software,  Inc. in the United  States.  On July 30,  1997,  the Court  permitted
Eastman  Software,  Inc. and Kodak Limited of England to be  substituted  in the
litigation in place of Wang.  The Company  cannot  predict what impact,  if any,
this will have on the litigation.

If it should be determined that the patents at issue in the litigation are valid
and  are  infringed  by any  of  the  Company's  products,  including  Watermark
products,  the Company will,  depending on the product,  redesign the infringing
products  or seek to obtain a license  to market the  products.  There can be no
assurance  that the Company will be able to obtain such a license on  acceptable
terms.

Dependence  On Certain  Relationships  The Company has entered  into a number of
co-marketing  relationships with other companies such as Microsoft  Corporation,
Compaq  Computer   Corporation,   SAP  AG,   Hewlett-Packard   Company  and  Sun
Microsystems,  Inc.  There can be no  assurance  that these  companies  will not
reduce or discontinue their relationships with or support of the Company and its
products.

Dependence  On Key  Management  and Technical  Personnel  The Company's  success
depends to a  significant  degree upon the  continued  contributions  of its key
management,  marketing,  technical and operational  personnel.  In general,  the
Company does not utilize employment  agreements for its key employees.  The loss
of the  services  of one or more key  employees  could have a  material  adverse
effect on the Company's operating results.  The Company also believes its future
success  will  depend in large  part upon its  ability  to  attract  and  retain
additional highly skilled management,  technical, marketing, product development
and  operational  personnel.   Competition  for  such  personnel,   particularly
engineers  and other  technical  personnel,  is  intense,  and pay scales in the
Company's  industry are  increasing.  There can be no assurance that the Company
will be successful in attracting and retaining such personnel.

   
International  Sales  Historically,   the  Company  has  derived   approximately
one-third of its total revenues from international sales. International business
is subject to certain risks including varying technical  standards,  tariffs and
trade  barriers,  political and economic  instability,  reduced  protection  for
intellectual property rights in certain countries,  difficulties in staffing and
maintaining foreign operations,  difficulties in managing foreign  distributors,
varying   requirements   for   localized   product,   potentially   adverse  tax
consequences, currency exchange fluctuations including those related to the EURO
beginning  in 1999,  the  burden of  complying  with a wide  variety  of complex
operations,  foreign  laws,  regulations  and  treaties and the  possibility  of
difficulties in collecting accounts  receivable.  There can be no assurance that
any of these  factors will not have a material  adverse  effect on the Company's
business or operating results.
    

Product  Liability The Company's  license  agreements  with customers  typically
contain  provisions  designed  to limit  their  exposure  to  potential  product
liability  claims.  However,  it is possible  that such  limitation of liability
provisions  may  not be  effective  under  the  laws of  certain  jurisdictions.
Although the Company has not experienced any product  liability  claims to date,
the sale and support of products may entail the risk of such  claims,  and there
can be no  assurance  that the Company will not be subject to such claims in the
future. A successful  product  liability claim brought against the Company could
have a material adverse effect upon the Company's  business,  operating  results
and financial condition.

Stock Price  Volatility  The Company  believes  that a variety of factors  could
cause the trading price of its common stock to fluctuate, perhaps substantially,
including quarter-to-quarter  variations in operating results;  announcements of
developments related to its business;  fluctuations in its order levels; general
conditions in the technology sector or the worldwide  economy;  announcements of
technological  innovations,  new products or product enhancements by the Company
or its  competitors;  key  management  changes;  changes in joint  marketing and
development  programs;  developments  relating to patents or other  intellectual
property rights or disputes;  and  developments  in the Company's  relationships
with its customers, distributors and suppliers. In addition, in recent years the
stock market in general,  and the market for shares of high technology stocks in
particular,  has experienced  extreme price  fluctuations  which have often been
unrelated to the operating performance of affected companies.  Such fluctuations
could adversely affect the trading price of the Company's common stock.



<PAGE>


PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

See Notes to Consolidated Financial Statements.

Item 6.  Exhibits and Reports on Form 8-K

     (a)  Exhibits - The list of exhibits contained in the accompanying Index to
          Exhibits is herein  incorporated by reference.

     (b)  No reports on Form 8-K were filed during the third quarter of 1998.




                                       19
<PAGE>


                                    SIGNATURE

Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned, thereunto duly authorized.


                                 FILENET CORPORATION

November 16, 1998                By:___________________________________________
Date                                Mark S. St. Clare, Chief Financial Officer
                                    and Sr. Vice President, Finance
                                    (Principal Financial Officer)






                                       20
<PAGE>
                                INDEX TO EXHIBITS

Exhibit No.             Description
 ....................... ........................................................

 3.1*    Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1
         to Form S-4 filed on January 26, 1996; Registration No. 333-00676).

 3.1.1*  Certificate  of  Amendment of  Restated  Certificate  of  Incorporation
         (filed  as  Exhibit 3.1.1  to  Form  S-4  filed  on  January  26, 1996,
         Registration No. 333-00676).

 3.2*    Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement
         on Form S-1, Registration No. 33-15004 (the "Form S-1")).

 4.1*    Form of  certificate evidencing  Common Stock  (filed as Exhibit 4.1 to
         the Form S-1, Registration No. 33-15004).

 4.2*    Rights  Agreement,  dated  as  of   November  4, 1988  between  FileNET
         Corporation and the  First National Bank of Boston,  which includes the
         form of  Rights Certificate as  Exhibit A and the  Summary of Rights to
         Purchase  Common Shares as Exhibit B  (filed as Exhibit 4.2 to Form S-4
         filed on January  26, 1996; Registration No. 333-00676).

 4.3     Amendment One dated July 31, 1998 and  Amendment Two dated  November 9,
         1998 to Rights Agreement,  between  FileNET  Corporation and BANKBOSTON
         N.A., formerly known as the First National Bank of Boston.

10.1*    Second  Amended and  Restated  Credit  Agreement (Multicurrency) by and
         among the  Registrant and  Bank of  America  National Trust and Savings
         Association  dated  June 25,  1997,  effective  June 1, 1997  (filed as
         Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 1997).

10.2*    Business  Alliance Program Agreemen  between the  Registrant and Oracle
         Corporation date  July 1, 1996,  as amended  by  Amendment  One thereto
         (filed as  Exhibit  10.4 to  Form 10-QA  for the quarter ended June 30,
         1996).

10.3*    Runtime   Sublicense   Addendum   between   the  Registrant  and Oracle
         Corporation  dated July 1, 1996, as  amended by  Amendment One  thereto
         (filed  as  Exhibit 10.4 to  Form 10-QA for the  quarter ended June 30,
         1996).

10.3.1   Runtime  Sublicense   Addendum   between  the   Registrant  and  Oracle
         Corporation dated July 1, 1996, as amended by Amendment Two through Six
         herein.

10.4*    Full Use and  Deployment Sublicense Addendum between the Registrant and
         Oracle  Corporation  dated  July 1, 1996,  as  amended by Amendment One
         thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June
         30, 1996).

10.5*    Lease  between  the  Registrant  and   C. J. Segerstrom & Sons  for the
         headquarters  of the Company,  dated April 30, 1987  (filed as  Exhibit
         10.19 to the Form S-1).

10.6*    Third Amendment to the Lease between the Registrant and C.J. Segerstrom
         &  Sons  dated  April  30, 1987,   for  additional  facilities  at  the
         headquarters of the  Company, dated  October 1, 1992  (filed as Exhibit
         10.7 to Form 10-K filed on April 4, 1997).

10.7*    Fifth Amendment to the Lease between the Registrant and C.J. Segerstrom
         & Sons dated April 30, 1987, for the extension of the term of the lease
         dated  March 28, 1997 (filed   as  Exhibit 10.8 to  Form 10-Q  for  the
         quarter ended March 31, 1997).

10.8*    1989   Stock   Option   Plan  for   Non-Employee  Directors  of  FileNE
         Corporation, as amended by the First Amendment, Second Amendment, Third
         Amendment thereto  (filed as  Exhibit 10.9 to Form S-4 filed on January
         26, 1996; Registration No. 333-00676).

10.9*    Amended  and  Restated  1995  Stock  Option  Plan  of FileNET (filed as
         Exhibit 99.1  to Form S-8 filed on  November 9, 1998;  Registration No.
         333-66997).
--------------------------------------------
* Incorporated herein by reference
                                       21
<PAGE>

Exhibit No.             Description
 ....................... ........................................................

10.10*   Second Amended and Restated Stock Option Plan of  FileNET  Corporation,
         together  with  the  forms  of  Incentive  Stock  Option  Agreement and
         Non-Qualified Stock Option Agreements (filed as Exhibits 4(a), 4(b) and
         4(c), respectively, to the Registrant's  Registration Statement on Form
         S-8,  Registration No. 33-48499),  and an  Amendment  thereto (filed as
         Exhibit 4(d) to the  Registrant's  Registration  Statement on Form S-8,
         Registration No. 33-69920),  and the Second Amendment thereto (filed as
         Appendix A to  the  Registrant's  Proxy  Statement for the Registrant's
         1994 Annual Meeting of Stockholders, filed on April 29, 1994).

10.11*   Non-Statutory  Stock Option  Agreement  (with Notice of Grant of  Stock
         Option  and  Special  Addendum)  between Registrant and Mr. Lee Roberts
         (filed as Exhibit 99.17 to Form S-8 on August 20, 1997).

10.12*   Non-Statutory  Stock  Option  Agreement  (with Notice of Grant of Stock
         Option and Special Addendum) between  Registrant and Mr. Ron Ercanbrack
         (filed as Exhibit 99.19 to Form S-8 on August 20, 1997).

10.13*   Agreement  for  the  Purchase of  IBM products  dated December 20, 1991
         (filed on May 5, 1992 with the  Form 8 amending the Company's Form 10-K
         for the fiscal year ended December 31, 1991).

10.14*   Amendment #A1011-941003-01  dated  September 30, 1994, to the Agreement
         for the  Purchase of  IBM products  dated  December 20, 1991  (filed as
         Exhibit 10.12 to form 10-K for the fiscal year ended December 31,1996).

10.15*   Developmen  and  Initial Supply  Agreement  between the  Registrant and
         Quintar Company dated  August 20, 1992  (filed as Exhibit 10.21 to Form
         10-K for the year ended January 3, 1993).

10.16*   Amendment dated December 22, 1992 to the Development and Initial Supply
         Agreement between the  Registrant and Quintar Company  dated August 20,
         1992 (filed as Exhibit 10.22 to Form 10-K for the year ended January 3,
         1993).

10.17*   Product License Agreement between the Registrant and Novell, Inc. dated
         May 16, 1995 (filed as Exhibit 10.26 to Form 10-Q for the quarter ended
         July 2, 1995).

10.18*   Agreement  and  Plan  of  Merger  between the  Registrant and Watermark
         Software Inc. dated July 18, 1995  (filed as Exhibit 10.27 to Form 10-Q
         for the quarter ended July 2, 1995).

10.19*   Agreement  and   Plan  of  Merger  between  the  Registrant  and  Saros
         Corporation, as amended, dated January 17, 1996 (filed as Exhibits 2.1,
         2.2, 2.3, and 2.4 to Form 8-K on March 13, 1996).

10.20*   Stock  Purchase  Agreement   by  and  Among  FileNET  Corporation,  IFS
         Acquisition Corporation,  Jawaid Khan and Juergen Goersch dated January
         17, 1996 and Amendment 1 to  Stock Purchase Agreement dated January 30,
         1996 (filed as  Exhibit 10.2  to Form 10-K for the  year ended December
         31, 1995).

10.21*   Amended and  Restated FileNET Corporation  1998 Employee Stock Purchase
         Plan  (filed as Exhibit 99.15 to Form S-8,  filed on  November 9, 1998;
         Registration No. 333-66997).

10.22*   FileNET  Corporation  International Employee Stock Purchase Plan.(filed
         as Exhibit 99.16  to Form S-8, filed on November 9, 1998;  Registration
         No. 333-66997).

27       Financial Data Schedule.

---------------------------------------------
* Incorporated herein by reference
                                       22